FX Focus: UK rate outlook and chart levels to watch

Coming off the back of a very busy week, the markets will have some time to digest the events of last week and turn their attentions to valuation rather than momentum.  

Based on the fact that currencies have been moving off the back of interest rate differentials, there is clearly no reason to turn the tide on the dollar (USD) and, as the trade tariffs may be a detractor to growth prospects from retaliation, economic divergence puts the USD in the driving seat.

Last week's price action had a heavy hint of waiting on the twin risk events of the Federal Open Market Committee (FOMC) and European Central Bank (ECB) meetings and getting them out of the way. With all cards on the table, the market turned a euro (EUR) sell-off into a broader USD rally which saw all the major currency counterparts pushing back to their respective lows, albeit to varying degrees.  

Now that the Fed are more inclined to hike four times this year, data watching will have been heightened, but with a potential skew of USD downside should the numbers not match up with expectations.  

The US dollar index (DXY) is back at the 95.0 level and facing a fair amount of congestion here, but, at the present time, and as we have already mentioned, there is little from an economic and rates perspective which suggests the move will stall here at the very least, with upside to resume eventually.  

President Trump's war on trade (deficit) has all the hallmarks of a full-scale attack on imports - notably from China and Europe, with Japan also in the mix as foreign cars are now on the agenda and will impact on the big names led by Toyota and Nissan.  

More products are set to be targeted from China as the president has said that he will respond to any retaliation, and Europe has also wasted no time in imposing its own taxes on well known 'home' brands and national products (Harley Davidson and Bourbon) to ramp up a potential escalation of economic warfare, prompted by the metals tariffs imposed from the start of this month. 
Neither the USD nor the safe havens have reacted to this as yet.  

We continue to see USD/JPY (yen) pushing for the 111.00 mark and possibly higher, while USD/CHF (Swiss franc) has recharged its batteries and is grinding a slow path back towards parity, but emphasis on the word 'slow'. 

Maintaining pressure on the JPY is the Bank of Japan's (BoJ) insistence that powerful easing is here to stay as long as inflation remains low. But on this there are murmurings that central bankers may start to consider lowering the (inflation) target, and this could imply the BoJ is finding ways and reasons to curb their asset buying program which has ballooned their debt to GDP to over 250%.  

This was partly a driver of JPY strength earlier in the year, largely on fears around normalisation, but exit strategy is a long way off.  Even so, if this does little to address the dis-inflationary mindset, then the BoJ will have to reassess and reassess quickly and this could impact on the JPY significantly.  

Past performance is not a guide to future performance

In the meantime, EUR/USD weakness is ingrained in the market, not least of all due to the ECB's 'assurances' that rates will not move until after mid-2019.  

Ending the current asset purchase programme through to end Sep and putting in a €15 billion to the end of the year was also seen as a dovish exit and, as some sources have suggested, there were some members among the governing council who preferred to keep this channel of accommodation open ended for now.  

From here, any drop off in the pace of growth will be monitored, but with a natural bias to the downside given how trade wars can affect the leading member states.  German surveys have shown nervousness on prospects going forward, and factory orders and production levels have been weak points of note recently.  

We saw (EUR/USD) 1.1855-60 met with a wall of selling interest on the initial reaction to the ECB announcement last week, and it will take some significantly positive developments to see this breached, or alternatively a major shift in sentiment on the USD.  

Fed speakers this week could have an impact, as the shift in the dot plot could be detailed a little more and perhaps reined in.  

Past performance is not a guide to future performance

Cable price action was similar in the mid-to-upper 1.3400's and, at the start of the week, the market looks more inclined to test the cycle low of 1.3200 rather than focus its energy on retesting 1.1500 in EUR/USD. 

Over the weekend, UK prime minister Theresa May received criticism from a range of sources in claiming that the windfall gains from EU contributions no longer in place would be divested into the NHS.  

Among them were the Institute of Fiscal Studies which said there was no hard proof that there would indeed be a windfall gain, and this runs concurrently with reports that a possible breakdown in talks with the EU leading to a no deal scenario would effectively lumber households with higher costs of up to £1,000 a year. 

Disruptions at customs and EU tariffs are significant risks which have been highlighted, and as such have further dampened the optimism over Brexit which was held with such confidence earlier this year!

Looking ahead, the Bank of England (BoE) meets on Thursday, and there is very little chance that on-hold members of the Monetary Policy Committee (MPC) will join Messrs McCafferty and Saunders in calling for a rate hike.  

Past performance is not a guide to future performance

August is now deemed 50/50 to produce a rate move, but despite the improved data inputs for Q2, market sentiment is clearly skewed for a move later this year - if at all.  

The risk over this week's meeting is in how they interpret the recent data run, where we have seen the latest PMIs all pointing to improvement of varying degrees. 

Indeed, this explained the tame response to the Apr industrial production numbers released a week ago. Services PMIs were the main focus, where the index rose from 52.8 to 54.0 (Apr to May), and alongside this we have also seen both Apr and May showing a healthy rebound in retail spending which should bolster GDP for Q2 further down the line.  

Consequently, this could be an interesting week for EUR/GBP which has been throttled inside a 0.8700-0.8850 range for some time now, but notable has been the consistent selling on all moves seen above 0.8800 in the last few months.  

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